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Cash is king in times like these: Pape

The headline in last Monday’s issue of The Wall Street Journal read: “Latest Fund Fashion: Cash”.

The drop line emphasized the point: “Stormy markets have public pension plans and mutual funds scurrying for cover”.

It seems that institutional money managers are keeping more of their money in cash than at any time since 2004. An analysis by the influential newspaper found that large retirement plans and open-end mutual funds have pulled about $200 billion (U.S.) out of the stock market since the middle of 2014.

If the pros think that’s a good idea, maybe we should pay attention.

Some money managers refuse to build large cash reserves, insisting that their clients expect them to be close to fully invested at all times. Being out of the market means potentially missing opportunities, the theory goes. Personally, I prefer a more tactical approach. It’s fine to be all-in when markets are positive, even if the growth isn’t robust. But in times of great uncertainty and high volatility such as we are currently experiencing, I like to have some cash in reserve to cushion any stock losses and to deploy as buying opportunities appear.

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That’s the scenario we face at present. The New York stock market just got off to the worst start of the year in its history; combine that with the turmoil in the oil markets and the economic reverberations from China and this seems to be a time to hunker down if there ever was one.

The knock against cash, of course, is that the returns are virtually nil in this period of low interest rates. The average Canadian money market fund returned 0.17 per cent in 2015. As I write, the yield on Canadian three-month, six-month, and one-year Treasury bills is 0.44 per cent. A high interest savings account at a small bank might give you 0.8 per cent. People look at those numbers and, not surprisingly, ask why anyone would hold money in cash.

Well, for starters, at least you’re not losing much. The annual inflation rate as of the end of November stood at 1.4 per cent, according to Statistics Canada. So there is just a small amount of purchasing power erosion each year.

But let’s keep things in perspective. The S&P/TSX Composite Index lost more than 11 per cent last year and another 4.3 per cent in the first week of 2016. Any money held in cash would not have been exposed to that drop.

Anyone who was smart enough to hold U.S. cash rather than Canadian loonies actually made a fat profit. The greenback was up almost 20 per cent against our currency last year, making U.S. cash one of the most profitable places for your assets.

Don’t misunderstand me. I am not advocating selling all your stocks and equity mutual funds and keeping the money in a bank account. Very few professional money managers would ever consider such a drastic course.

Rather, I suggest setting a target level for the cash position in your portfolio that is consistent with your age, risk tolerance, and market conditions. The older you are, the higher that target should be. For example, people in their 70s who are depending on their investments for some of their retirement income should keep about one year’s worth of cash requirements in a savings account or some other type of liquid investment. That allows you to ride out temporary declines in the market.

Younger people who don’t expect to need access to the money in the near future can go with a smaller amount.

Beyond the fact it is quite recent, no one seems to know where the phrase “cash is king” originated. What we do know is that if there ever was a time that it was appropriate, this is it.

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